Does Kosmos Energy (NYSE:KOS) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Kosmos Energy Ltd. (NYSE:KOS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kosmos Energy

What Is Kosmos Energy's Debt?

As you can see below, at the end of September 2024, Kosmos Energy had US$2.69b of debt, up from US$2.39b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

A Look At Kosmos Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Kosmos Energy had liabilities of US$563.2m due within 12 months and liabilities of US$3.71b due beyond that. Offsetting these obligations, it had cash of US$51.6m as well as receivables valued at US$162.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.06b.

This deficit casts a shadow over the US$1.64b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Kosmos Energy would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kosmos Energy's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 13.2 times, makes us even more comfortable. Notably, Kosmos Energy's EBIT launched higher than Elon Musk, gaining a whopping 201% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kosmos Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Kosmos Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Kosmos Energy's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Kosmos Energy has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Kosmos Energy you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.